Red Flags to Detect Fraudulent Financial Reporting in Indonesian Banking Sector

Abstract

Indonesian banking sector suffer huge loss because of fraud. In some cases, perpetrators attempt to commit fraud concealment by conducting financial restatement, even though the financial statement information was used by stakeholders for decision making. As a consequence, this concealment can reduce the quality of financial statement information. Furthermore, the poor quality of financial statement information can reduce the level of accuracy of stakeholders in making economic decisions. Therefore, before fraud occurs, red flags must be detected early as an early warning of an ethical action taken to occur. The fraud pentagon approach can detect potential fraud that occurred through five components, namely pressure, opportunity, rationalization, competence, and arrogance. This study aims to examine the potentiality of fraud pentagon components as red flags to detect fraudulent financial reporting in Indonesian banking sector. This study conducted in banking sector companies that listed on the Indonesia Stock Exchange for the period 2015 to 2018. Logistic regression is used to empirically prove the research objectives. This research succeeded to prove that the higher pressure can increase the company to commit financial reporting fraud and the higher opportunity can reduce the company to commit financial reporting fraud. Nonetheless, the rationalization, competence and arrogance do not affect the company to commit financial reporting fraud. This results can provide recommendations to the Indonesian banking sector to strengthen their internal control systems and implement an anti-fraud program that is not just obeying the rules, but because of their awareness to obey them.